The professors demonstrated no such thing. They started with an assumption and then used economics to justify it. Their assumption is that labour costs have nothing to do with unemployment. The first thing to note is that marginal productivity can never be distributed. It is absurd to even suggest such a thing. What is really being asserted is that the marginal value of the unskilled workers’ output has collapsed.

The importance of this approach is that it leads to the conclusion that a very high minimum wage rate can be imposed with little or no effect on the level of unemployment. (In the jargon of the economist, the demand curve for labour is inelastic). To demonstrate this point, Gittins provides the hypothetical situation where there are

500,000 men, with an elasticity of only minus 0.3, then a cut of as much as 80 per cent would lead to no more than 120,000 additional jobs.

Let us start with a very simple observation. According to Gittins if these 500,000 men were paid $500 per week then an 80 per cent wage cut would drive the weekly payroll down from $250,000,000 to $62,000,000! Now this is the kind of figure that should cause any economist to pause for a moment’s thought, but not our Mr Gittins.

Economics states that in a free market there is a tendency for every factor to receive the full value of it marginal product. Now this is something that Gittins, Gregory and Frijters are not denying. What they are doing is ignoring its ramifications for their own ‘theory’.

According to the professors’ thesis the demand curve must be very steep and that the market clearing price for labour will beat a very low point, as shown in figure 1. Using the professors’ figures we also see that between MW (the minimum wage) and E (the market clearing wage) there is a huge difference between the market price and the minimum wage. This difference consists of a range descending marginal productivities. Let us now assume that there is no minimum wage and that E is the prevailing rate. The likes of Gittins, Gregory and Frijters would be outraged, arguing that the rate MW can be safely imposed with very little effect on the unemployment rate while yielding a huge benefit to the low paid. But is it that simple?

This brings us to the basic point that market processes move to equalise returns and eliminate profits. Figure 1 clearly shows that there are huge profits to be made out of hiring more labour. If this were not so then the demand curve would be comparatively flat, meaning that it would be elastic instead of inelastic. By competing with each other to hire more labour these firms would increase their total output and raise wages. The final result would be something like figure 2 where E is the market rate. Wages would be less than $500 dollars but far higher than $100. And there is nothing in these professors’ paper that could prove it would be otherwise. Let us take another situation that is perfectly valid. Figure 3 shows that if the minimum wage is set at any point in the A to B zone there will be no impact on unemployment. The area between A and B is therefore inelastic while the area above A and below B is elastic. This means that because any movement within this zone would have no effect on the demand for labour minimum wage advocates would erroneously claim that the demand for labour is inelastic. However, if the minimum wage was set between B and E unemployment would rise. It follow that allowing wage rates to settle at E will raise the demand for labour and probably increase payrolls as well. We must bear two things in mind: 1) supply and demand analysis is not always as straightforward as it looks and 2) what matters is the effective minimum wage, i.e., the rate that exceeds the market clearing rate. Can Gittins or Gregory and Frij prove that figure 3 does not represent the true situation? Of course not. The problem with the formula for elasticity is that it yields precise but spurious results. It claims to measure the response of demand to a change in price, which implies the existence of a constant. But elasticity is not a constant, not only will it vary over the range of any demand schedule the schedule itself is always changing, which in turn changes the elasticities. For elasticity to be constant consumer preferences would have to be frozen. Professor Frank Knight probably expressed it best when he wrote:

Serious embarrassment arises from the fact that there is no conceivable way of determining the elasticity of either demand or supply with reference to any particular time period. . . . The conditions underlying either curve will never remain constant. . . . As to the chance of making any estimate or calculation of elasticity for any real period, the possibilities in the abstract are limited enough on the supply side, but are virtually zero on that of demand. (The Economic Organisation, Augustus M. Kelley, 1951).

A far more fruitful approach is to try and compare the average value of production against total labour costs (the real gross wage). This is what Professor C. Benham did (The Prosperity of Australia, P. S. King & Son, LTD, Orchard House, Westminster, 1928). The following table was the illuminating result.

Table 1 Queensland: Wages, Production and Unemployment
Year	Average Wages	Value of production per worker	%.Unemployed
1916 1917 1918 1919 1920 1921 1922 1923 1924	£    d 60   4 65    5 69    6 78    7 91    6 96    8 93  10 94    2 94  11*	£ 287.60 325.19 316.62 305.40 362.57 338.91 339.84 370.00 424.78	5.8   7.0   9.3 11.1 13.3 15.5 10.0   7.1   6.4
*Average for nine months

He focused on the observation that unemployment rose as wages rose “relatively to the value produced per worker”. In his own words: “It would be hard to find a clearer proof of our thesis [that excessive wage rates cause unemployment]”. His table for unemployment in Queensland was used to construct the following chart.

The left hand side measures unemployment in per centages while the right hand side is the ratio of the value of production to the average wage. It can be easily seen that the lower the ratio the higher the level of unemployment, with a ratio of about 3.5 giving us an unemployment rate of 15.5 per cent. The unemployment situation was strikingly similar to our own, with The Royal Commission on National Insurance (1926) finding that most of the unemployed were unskilled. It concluded that wage rates had been fixed too high. (In Gittins scholarly view this would probably make the Royal Commission a bunch of ideologues).

Gregory and Frijters would argue that the current situation very different from that of the 1920s and that “globalization, standardization, and computerization [have led] to reduced marginal productivity for the low-skilled and higher marginal productivity for the high-skilled”.

They are making assertions, not stating facts or statistics. This is no way to conduct a serious economic debate. The globalisation accusation smacks of the Stolpert-Samuelson theorem. This predicted that free trade would lower the real income of relatively scarce labour that is producing tradable goods that can be bought from other countries in which similarly skilled but abundant (cheap) labour is also being used in their production.

The fallacy here is the implicit assumption that ‘expensive’ labour in the rich country is specific, i.e., it has no alternative use, or that it has extremely large discontinuities between its marginal productivities. In my opinion this is impossible, and Gregory and Frijters provide no evidence to the contrary.

As this pair well know, labour is faced with a descending array of the value of its marginal productivities and these are the result of the country’s capital structure. (Neo-classical economists would call it the capital stock). In other words, our labour is paid more than, for example, Indonesian or Vietnamese labour because in comparison with them we are capital-land abundant country. Therefore, importing cheaper goods from these countries cannot bring about an unfavourable change in our labour capital-ratio and thus drive down real wages rates.

Failure to grasp this point is due to confusing the importation of the products of labour services with the importation of labour itself. Moreover, to lend support to their contention that globalisation (free trade) has driven down the marginal productivity of unskilled Australian labour they would have to show that the price of traded goods had fallen. The latter is very important because wage equalisation would be brought about by changes in the relative prices of goods.

This means that the prices of tradable goods produced by unskilled Australian labour would have to fall. Now even if this was true they would have explain how these prices changes lowered real wages. The only possibility is that unskilled labour is specific. But all labour is highly non-specific.

Now if the capital structure shortened or the amount of unskilled labour grew faster than the capital stock then real wage rates would have to fall if the labour market was to clear. (This is a possibility that neither Gittins nor Gregory and Frijters considered). Much as I should like to take credit for this idea the recognition goes to the remarkable Mountifort Longfield. In his Three Lectures on Commerce and one Absenteeism (1835) he drew attention to the consequences of spending on consumption at the expense of capital goods, pointing out that this could bring about an unfavourable change in the structure of production which might lower wage rates.

He argued that if absentee English landlords spent their rents on buying French dresses and lace for their female companions rather than invest it in their Irish farms this could alter the factorial terms of trade for Ireland. In my mind this raised an intriguing question: Would a lengthy expansionary monetary policy have the same detrimental effect? Perhaps Mr Gittins could spare a few precious moments from his busy schedule to give this tantalising thought a little of his consideration.

By attributing some of the blame for unemployment to “standardization, and computerization” Gregory and Frijters are slyly applying the labour-lump fallacy that has it there is a fixed amount of work to be done and so the introduction of labour-economising machinery causes a net loss of jobs. We normally call this Luddite economics. In the 1800s there workers rioted against the introduction of machinery because they thought they would lose their jobs. (See how Jean-Baptiste Say treated this issue in his Treatise on Political Economy, Transaction Publishers, 2001, originally published in 1836 by Grigg & Elliot). John Stuart Mill’s contribution is particularly instructive. He wrote that

It is true that if all the wants of all the inhabitants of a country were fully satisfied, no further capital could find useful employment; but, in that case, none would be accumulated. So long as there remain any persons not possessed, we do not say of subsistence, but of the most refined luxuries, and who would work to possess them, there is employment for capital; and if the commodities which these persons want are not produced and placed at their disposal, it can only be because capital does not exist, disposable for the purpose of employing, if not any other labourers, those very labourers themselves, in producing the articles for their own consumption. Nothing can be more chimerical than the fear that the accumulation of capital should produce poverty and not wealth, or that it will ever take place too fast for its own end. Nothing is more true than that it is produce which constitutes the market for produce, and that every increase of production, if distributed without miscalculation among all kinds of produce in the proportion which private interest would dictate, creates, or rather constitutes, its own demand. (Of the Influence of Consumption on Production, 1829).

Unfortunately the fallacy did not end with Mill’s refutation. The Great Depression panicked many people in to believing that too much machinery had led to over production because workers were not paid enough to buy the products they produce. In the 1960 there was a brief outbreak of “automation hysteria” . (See George Terborgh, The Automation Hysteria, Norton & Company Inc., 1966). This too passed away.

Then the 1980s gave us Australian unions whinging about the job-destroying effects of computers. Their reactionary remedy for this non-problem was — and I kid you not — to call for a moratorium on their use. It is now 2006 and two professors of economics plus one so-called economics journalist are repeating the same sorry saga. And Gittins has the bloody nerve to accuse free marketeers of being ideologues. (See The myth of technological unemployment: another Liberal Party failure)

The authors also slipped in the fallacy of surplus capital. (This is closely related to the previous fallacy). This means that the existing capital structure has become too specialised for unskilled labour to work causing unemployment to emerge. Now it is true that as an economy advances capital goods tend to become more specialised. But the effect of this is not to increase unemployment but to continually keep at bay the law of diminishing returns, (Ludwig M. Lachman, Capital and Its Structure, Sheed Andrews and McMeel Inc, 1978).

The depressing thing about all of this is that it was firmly dealt with 172 years ago by Mountifort Longfield in his Lectures on Political Economy, 1834. In these lectures he described how capital accumulation raised wage rates for everyone and why capital could not capture all the profits. His work was elaborated on by Isaac Butt who successfully applied his analysis to other factors of production.

We now turn to Professor Samuelson  s approach to the subject. Irrespective of what, Gregory and Frijters think labour and capital are complementary factors. Therefore, if the supply of capital goods increases relative to the supply of labour then labour incomes rise. This process is illustrated by the following table that was taken from Paul Samuelson’s Economics(10th, edition, 1976).

I made several changes to the table. Whereas Samuelson uses land as his fixed input I use capital. Production consists of a single stage at the point of consumption. Capital is homogeneous and consists of 1,000 units equalling 1,000 capitalists. Labour is also treated as homogeneous.

Relation of output to labour and Capital
	1 units of capital	2 man-days of labour	3 output of consumer goods	4 wage in consumer goods per day	5 labour's share of GNP (%)	6 rent in consumer goods per unit of capital
A	1000	500501	40004008	8	100	0
A'	1000	10001001	80008008	8	100	0
B	1000	30003001	20,00020,005	5	75	5
E	1000	60006001	33,360   33,604.2	4.2	75	8.4
Z	1000	8,0008,001	39,000 39,000	0	0	39

The table makes it clear that the height of real wage rates is determined by the capital-labour ratio. The higher the ratio of capital to labour the higher the real wage rate,* and vice versa. As we can see, beyond a certain point the return to labour falls but starts increasing for capital. In other words, the increase in the supply of labour against a given capital structure lowers wage rates relative to the price of capital goods.

I can honestly say that I do not know of a single instance where an increase in per capita investment caused a collapse in the marginal productivity of unskilled labour. And I am not alone in my observations. Paul Krugman wrote:

History offers no example of a country that experienced long-term productivity growth without a roughly equal rise in real wages. (Pop Internationalism, The MIT Press, 1997).

The following chart is just one of many that show wages moving in tandem with productivity.

But for some strange reason this economic phenomenon bypassed Australia. In fact, critics of free labour markets do not even refer to this empirical evidence let alone the economic thinking behind it. (To be fair, neither does our rightwing). If the above was accepted by market critics they would then be forced to blame our unemployment on excessive labour costs.

Another example of the anti-market approach to free labour markets is to blame a fall in real wages for any shortening of the capital structure. For example, Capital Shallowness: A Problem for New Zealand? (Julia Hall and Grant Scobie, New Zealand Treasury Working Paper, June 2005) blames the freeing of New Zealand’s labour market for a decline in the capital stock which in turn lowers real wages even further. According to this line of thought, cutting real wages leads to cuts in investment which leads to further falls in real wages which then leads to ...

Now a collapse in the marginal productivity of unskilled labour does not mean their physical output has dropped, only that its value has plummeted. So if the marginal physical output of the unskilled has remained unchanged could its value drop? Yes. As there is no evidence that imports have driven down the values of unskilled labour that leaves us with the supply side.

Samuelson’s table tells us that as the labour supply increases a point is reached where wage rates begin to decline. If the supply continues unabated wage rates will actually fall to zero. My point is that an increase in unskilled labour without a corresponding increase in capital goods would see wage rates fall. Total employment rose from 7.7 million in 1990 to 10 million today. This is an increase of nearly 30 per cent.

Let me summarise this: the likes of Gittins and Gregory and Frijters believe that free trade and increased capital specialisation have driven down the wage rates for the unskilled, while Julia Hall and Grant Scobie believe that free labour markets drove down wage rates by making labour cheaper than capital. But Tim Colebatch of The Age and Mike Steketee of The Australian wrote that increased productivity created the unemployment. Not one of them is prepared to admit that the problem could just be excessive labour costs. Anything but that.

So long as there is sufficient land and capital to employ all of those who able and willing to work widespread persistent unemployment will not emerge in an unhampered market. This does not say anything about the height of real wages. As I stated earlier on, these are determined by the capital-labour ratio

Gerard Jackson is Brookes’ economics editor

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